TCS Daily

The 'Central' Issue

By Kevin Hassett - February 20, 2003 12:00 AM

With the FCC set to announce the policies that it will employ to further phone competition, the debate between FCC Chairman Michael Powell and commissioner Kevin Martin has received an enormous amount of press coverage. Mr. Martin's split from Chairman Powell over the proper path to deregulation puts him in the uncomfortable political position of opposing a Chairman of his own party. That the debate between two colleagues could spill over into public view suggests that the disagreement is spirited and that core conservative principles are at stake. They are.

To understand the conflict, it is useful to think about the intellectual roots of the conservative view of regulation - a view that grew out of the work of University of Chicago professor and Nobel Laureate George Stigler. Prior to Stigler, economists generally motivated the regulation of certain industries with appeal to textbook monopoly models. In these models, a monopolist would jack up the price and cut back the output of its product in order to maximize profits. But a regulator could enter and make consumers better off by putting a cap on the price of the monopolist. All this worked well in theory, but this theory was shaken to its core in 1962 by Stigler's path-breaking study of electricity regulation that suggested that regulation had not improved consumer welfare in practice.

Out of this early and carefully documented work grew an academic school of thought that forms the foundation of the conservative view of regulation. Regulators do not generally work in the best interest of consumers, but rather, serve the regulated. By working together with the "monopolists," regulators help construct impediments to competition that secure the profits of regulated firms. The benefits from this game flow both ways. The more secure and healthy are the profits of the regulated, the more powerful and influential is the regulator. The conservative view of regulation is, thus, simple: don't do it.

With such a straightforward foundation, why are conservatives so at odds? Easy. The question today is not over whether one should attempt to limit the influence that regulators have over telephony, but rather, how to move from the current state to a world without regulation. That transition is tricky for a simple reason. We currently live in a world that regulated firms and "captured" regulators spent decades constructing. If we just close down the FCC it is possible that the moats that have been constructed around the local phone giants will rule out competition for years to come. In addition, the long-distance segment of the market may provide a useful road map to successful deregulation. In that case, the monopolist was required at first to lease its equipment to competitors, who gradually constructed competing networks as their client bases grew. Can a similar strategy work with respect to local phone and broadband service?

Mr. Martin and Mr. Powell are at odds over this difficult question, each with his own plan for relaxing regulations. They are not alone. If one were to assemble ten conservative economists and ask them to design a transition plan, they would produce ten plans. Stigler himself predicted such moments, chiding economists for converging too quickly to policy prescriptions in his 1965 American Economic Association presidential address: "the truly remarkable fact is not that economists accepting the same theory sometimes differ on policy, but that they differ so seldom." Since the world is more complex than our simple models, disagreement is a sign of progress.

But if Stigler taught economists anything, it is that theories must be confronted with hard evidence. Accordingly, it seems that the most reasonable approach at the present time would be to construct a fairly general transition outline, try a number of different policies - and then let the data do the talking. Use observation to identify the policies that have been the most successful in moving toward total deregulation.

In this particular application, it is relatively easy to accomplish such diversification. Each state has, and should have, a great deal of say in how telephony is regulated. So why not let them each experiment with different policies, and ask the central authority to keep track of their success. In order to minimize the influence of industry-generated propaganda, one might even insist that the opposing sides agree on a success metric ex ante. This rather pragmatic approach draws on another important strain of conservative doctrine that dates back to Hayek and Smith, namely the observation that competition improves outcomes. In this case, states that successfully deregulate will have a tangible business advantage over those that do not. The resultant state regulatory competition can help identify efficient policies. To summarize, one might say that the conservative view of regulation should be to deregulate, and to use competition to do so.

The details of the various positions have been spelled out in detail in a number of recent articles, but to me the interesting observation is that Mr. Martin has one idea about the appropriate federal regulations, while Mr. Powell has another. It is possible to understand the arguments supporting each view, but Mr. Powell's has an additional and unusual condition. He also has an objective of imposing his "central" view on every state regulator.

If a complete and thorough body of evidence existed suggesting that Mr. Powell had discovered the golden path to deregulation, then his approach might be sensible. Why use competition to discover the best path if we already know the answer? Such evidence is, of course, scanty, which leads to the million-dollar question. Why does Mr. Powell advocate the abandonment of a key conservative principle and the foreclosure of state policy competition? There is little doubt that the absence of a promising answer - other than that proposed by Stigler - accounts for Mr. Martin's principled objections.

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